Consumer Spending: Down, Not Out


By Heesun Wee With corporate earnings and capital spending still tenuous, the consumer continues to lead the economy toward a recovery -- despite recent consumer-related economic data that came in lower than expected. For investors, these first signs of spending fatigue imply more than a need to lower expectations for economic growth. It also means that they're likely to find fewer stock-buying opportunities in the consumer sector in the near term.

For the second consecutive month, retail sales came in lower than Wall Street anticipated. Rather than the 0.4% increase economists had been expecting, they rose just 0.2% in March, to $297.3 billion. Meanwhile, the University of Michigan's monthly consumer sentiment index -- a key confidence gauge -- slipped to 94.4, vs. 95.7 in the previous month. This move also fell short of analysts' forecasts, which envisioned the index rising to 96.5. Says David Wyss, chief economist at Standard & Poor's: "It does suggest that the consumer is getting a bit nervous."

Before investors jump to panicked conclusions about consumer spending, which accounts for two-thirds of U.S. economic activity, Wyss and other market watchers caution that the situation isn't really all that bad. The consumer, they say, will continue to lead the economy toward a more sustained recovery -- just at a scaled-back pace.

HIGHER BAR. "It's not that the consumer is ready to roll over, but that the fairly buoyant consumer already is priced into the market," says Subodh Kumar, chief investment strategist at CIBC World Markets. Continually topping high expectations for consumer spending and sentiment would be difficult, Kumar adds. For the most part, stocks in this sector are unlikely to keep hitting 52-week highs. That's because most of those shares already are at, or near, overbought levels.

"Although I believe the consumer will remain in place for those stocks to outperform, the bar has been raised, and I think they'll have trouble meeting it," says Kumar, who recommended early in April, 2002, that investors underweight stocks most affected by consumer discretionary spending. While some of these stocks may be in for profit-taking and a healthy dose of realism, a few opportunities remain for short-term gain in the sector.

Stocks in that group with exposure to the strong housing market, such as Home Depot (HD), and value plays like Target (TGT), the discount retailer, are likely to stay attractive. But those stocks aren't cheap. Home Depot is trading at more than 37 times fiscal 2002 earnings of $1.29 a share, while Target is changing hands at more than 28 times fiscal 2002 earnings of $1.56 a share.

"REALITY SETTING IN." As consumers continue to spend, albeit at a slightly slower clip, they may be experiencing a subtle transition. Historically, they're likely to maintain spending levels after a significant downswing in the markets -- as happened after September 11 -- and continue with normal patterns for months, explains A.C. Moore, chief investment strategist at Dunvegan Associates.

"The tendency is to keep a good face up, even at the expense of higher debt levels -- and even at the expense of increased financial vulnerability. Then, that gives way to decreased activity and reality setting in," Moore notes. "We're in some of that acceptance phase. But it doesn't mean a recovery isn't going to occur."

Moderating consumer spending may actually be a hidden blessing. Some economists point out that more positive consumer data could have rung an alarm with Alan Greenspan and his fellow central bankers. "It's reassuring to the Federal Reserve that we didn't see another sharp gain in retail sales and consumer sentiment," says Edward Deak, an economics professor at Fairfield University, who adds: "That would get the Fed worrying about too strong a recovery and maybe thinking about raising interest rates faster than they might otherwise do."

The bottom line: "Consumers are spending," says Lynn Franco, director of the Conference Board's Consumer Research Center. "And that trend doesn't seem like it's going to reverse itself." Wee covers financial markets for Business Week Online in New York


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